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The US financial sector has undergone a remarkable concentration as a consequence of the financial crisis. This consolidation potentially strengthens the resilience of the system by making its core institutions Really Too Big To Fail (no more Lehmans). The longer-term price, however, may be greater oligopoly power of the super-banks.
Despite the consolidation, bank capital adequacy remains under pressure, and banks are reluctant to lend. At the same time, after a major money market fund "broke the buck," money market mutual funds holding commercial paper are losing funds to those holding Treasury obligations. As a consequence, the threat is shifting from jeopardy to the financial system to a credit squeeze on manufacturing and non-financial services.
To help ease that credit crunch, the Federal Reserve and the US Treasury have stepped in with a new Commercial Paper Funding Facility (CPFF). Although unprecedented, the new CPFF follows logically from the present situation in which normal bank intermediation between depositors and borrowing real-economy firms is being squeezed and there is a need for some entity to take on the intermediation role.
This note focuses on the question of bank consolidation. For purposes of scaling the issue, figure 1 shows the size of each major block of the financial services sector as of June, 2008 (and hence before the morphing of investment banking into bank holding companies). As a whole, the sector holds about $24 trillion in assets, or about 170 percent of GDP. Commercial banks accounted for 37 percent in June, and are now 46 percent after the shift of Goldman Sachs and Morgan Stanley to bank holding company status.
Figure 1
Source: Federal Reserve and annual reports
The size of the forced transformations in the financial industry is huge against this benchmark. As shown in figure 2, the entities that have been forced into mergers (Countrywide, Bear Stearns, Merrill Lynch, Washington Mutual), placed under conservatorship (Fannie and Freddie, AIG), or allowed to enter bankruptcy (Lehman) amount to over $6 trillion in assets.1
Figure 2 Forced Transformations of Major Financial Institutions in 2008
Source: Federal Reserve and quarterly reports
One consequence of these transformations is that a large block of the financial services sector has effectively been socialized: the GSEs (Fannie and Freddie) and AIG together account for assets of $2.8 trillion. Another consequence is that a large block of assets has been shifted from weak institutions to larger and hopefully stronger ones. Figure 3 shows five institutions that have become extinct, as well as the remaining largest banks. A total of $2.7 trillion in assets has been shifted in this manner to four large banks.2 Another $690 billion has in effect evaporated from the US banking system with the bankruptcy of Lehman Brothers.
Figure 3 Assets of Major Disappearing and Surviving Banks
Source: Federal Reserve and quarterly reports
The consolidation has established only six banks as accounting for 67 percent of the assets of the banking system (Figure 4).3 Bank of America, Citigroup, and JP Morgan Chase each account for about 15 percent of the total system. Goldman Sachs, Morgan Stanley, and Wells Fargo each account for about 7 percent.4 The American subsidiaries of Deutsche Bank and HSBC account for about 4 and 3 percent of system assets, respectively; and US Bancorp and Bank of New York, about 3 percent and 1 percent, respectively. Bank size drops off rapidly after that, with the combined assets of the next 10 largest banks amounting to only about 7 percent of the system's total.
For the longer term, the increased concentration in American banking is problematical, because it poses questions of oligopoly pricing on the one hand and moral hazard inherent in Too Big to Fail status, on the other. For the present crisis phase, however, the consolidation is helpful. It means that if one of the remaining super-banks gets into extreme difficulty, it will almost certainly be saved through some variety of nationalization, while the other remaining banks are each too small to be system-threatening.
The expansion of FDIC coverage from $100,000 to $250,000 also should bolster confidence in the system. With an arguably stronger banking system, the focus of the crisis seems to have shifted from the financial sector toward the real economy.
Figure 4 Assets of Largest Banks as Percent of US Banking System Total
Source: Federal Reserve and quarterly reports
Notes
1. The amount here for Fannie and Freddie is their direct assets only, and excludes guarantees.
2. To JP Morgan Chase: $395 billion from Bear Stearns and $310 billion from WAMU; to Bank of America,$212 billion from Countrywide and $966 billion from Merrill Lynch; to Citigroup and/or Wells Fargo, $812 billion from Wachovia.
3. Total banking system assets for this calculation are the $9.1 trillion held by commercial banks in June plus the $2.1 trillion in Goldman Sachs and Morgan Stanley assets shifted to bank holding company status.
4. The figure assumes that half of Wachovia goes to Citigroup and the other half to Wells Fargo.
